ETF spreads a concern for ASIC

The corporate regulator has released Report 583: Review of exchange traded products, which is based on data gathered between 1 January 2016 and 30 September 2017.

ASIC’s review found the Australian exchange-traded product (ETP) sector is “generally functioning well and delivering on promises to investors”.

However, there are also “potential risks that require monitoring by issuers and oversight by market operators”, the report said.

Principal among those risks is the temporary widening of bid-offer spreads in some circumstances, said ASIC.

The phenomenon is down to the fact that market makers are not required to provide bids and offers for 100 per cent of the trading day, the report said.

This means that market events affecting the underlying assets (e.g. market volatility or market closure) can have an impact on spreads of the ETP.

“As the spread may significantly affect investor return, it is important that investors understand the size of the spread and its potential impact on their return when buying and selling ETPs,” the report said.

The report recommended that market operators “undertake a proactive review of the liquidity commitments of market makers and issuers” and monitor their quote spreads.

“We encourage issuers and financial advisers to inform investors about spreads in ETPs and how these may impact on trading strategies,” said ASIC.

The regulator also has concerns about the low number of market makers who have formal agreements with issuers for liquidity purposes, which results in “concentration risk” for the market.

Internal market making, which is used by active ETF providers, was a particular focus for ASIC.

The regulator recommended issuers who use internal market making should close or wind up the ETP if it cannot trade close to the net asset value (NAV).

In addition, ETPs with internal market making should “carefully manage and explain” any conflicts to investors, and ensure profits from internal market making are disclosed separately and excluded from performance fee calculations.

“We will continue to engage with the ETP industry about the monitoring of spreads on a more regular basis, appropriate to the nature of the underlying assets,” the report said.

“We will also continue to monitor the development of the ETP market and the experience retail investors are having when engaging with or investing in this market.

“The continuing growth in ‘active ETFs’ is likely to be an ongoing area of focus.”